Last updated on October 4th, 2024 at 07:38 am
Financial products can be explained as contracts that can be traded in the market. Someone is selling these contracts and others are buying the same. Financial products are financial instruments that are available in various forms.
The reason for introducing the concept of a financial product is that it lets individuals convert their fiat currency into something they can sell to others within a marketplace. Financial products can be classified into various categories. Read on to learn more about financial products and their major classifications.
Financial Products: Meaning and Definition
Financial products are generally referred to as any form of financial contract, which is equally well connected with financial infrastructure available to consumers and organisations or other entities such as government authorities, municipalities, sovereign bodies, etc. Such financial products are provided to consumers by financial institutions that consist of banks, brokerage companies, insurance agencies, investment, consumer finance, firms, and so on. All such institutions make up the financial services sector.
To understand ‘what are financial products’, one has to understand the concept of contractual agreement between two parties. One who promises to provide some service, in this case, it is financial service and the other who agrees to provide some consideration in exchange for receiving such service. The exchange of economic activities between the two parties establishes a continuous monetary relationship which facilitates the exchange of finance and ancillary services which is the foundation of the financial relationship.
The contractual agreement comes with a lot of legal provisions and is recorded in a terms sheet. Such agreement establishes continuous relationships during the lifetime of the financial product, depending upon various specified events. However, financial products are not real or tangible assets. These ancillary services can act as an asset for the companies that help them to facilitate the ongoing relationship between the parties.
Various effective banking courses are available that can help individuals to have an in-depth understanding of financial products.
Types of Financial Products
As per the technical carb of financial products, they can be classified into four major categories. There are several types of financial products. However, the major classifications are:
Securities
Securities are the most traded instruments by companies, financial organisations, public entities, government entities, banks, etc. Generally, securities are a means of entitlement to a specific thing, such as a promise to fulfil a contract or a claim to an asset. It is a type of financial product most widely used within a marketplace.
Therefore, securities are promises having a tangible or intangible existence. In such a case, the promisor promises something to the promisee, who is the holder of a security something proportional in exchange for the security they hold. Securities can be both long-term and short-term in nature depending upon the requirement and financial capacity of the security holder.
Some of the most common types of securities are enumerated as follows:
- Stocks
Stocks are the most commonly used securities, mainly when transactions occur between two or more businesses, financial institutions, government entities, etc. Stocks highlight part of ownership in an organisation. When someone purchases a stock, they get a share of ownership within the company.
Stock ownership comes with owning equity shares in a company and provides the owner with various rights and responsibilities. Such rights may include voting, representation, and decision-making rights. Companies sell stocks to individual investors to fetch finance for their operations.
Appreciation and depreciation of stocks may happen depending upon the market conditions. Appreciated stocks are a sign of profitability, whereas depreciated stocks represent losses. Investors buy stocks at lesser prices and when the value of the stocks increases, they sell them to earn profit.
- Bonds
Bonds are a form of loan that individuals extend to companies or public entities selling bonds to raise money for their operations. However, bondholders are not the owners of the company. They are the creditors of the organisation.
Bonds specify an obligation that the bond issuer will pay back the money along with the interest amount to the acquirer of the bond. This transaction will be completed on the maturity date of the bond. However, these are long-term investments with long maturity periods, such as 20 to 30 years.
Hence, bonds are nothing but loans advanced by individuals to companies. Acquiring bonds has fewer risk factors than buying stocks. At the same time, bonds yield lower returns than stocks. Stocks guarantee capital appreciation, whereas bonds fetch money through interest.
- Mutual funds
Mutual funds are a type of financial security that allows many people to invest their money to purchase securities. In mutual funds, investors can combine their money to purchase more than what they can buy themselves. Individuals get a portion of the fund proportional to the amount they invest.
Mutual funds are categorised as index funds and exchange-traded funds. The former is a combination of securities that keeps track of one particular index, whereas the latter can be traded in the market in the same manner as stocks. Index funds may provide a sense of ownership, but that’s not the case with exchange-traded funds.
Derivatives
A derivative is a financial product that derives its value from an individual or a group of individual securities. The simplest example of a derivative is a contract between a buyer and a seller where the price of the derivative fluctuates, depending upon the price shifts of the concerned asset, which is called the benchmark.
The most iconic feature of derivatives is that they are used to keep track of market fluctuations and movements, which helps companies or individuals leverage their holdings. Investors secure the right to buy or sell any security through derivatives at a specific time and price level. The risk associated with derivatives is considered to be high in capital markets.
Types of derivatives that are most widely used in the marketplace are stated as follows:
- Futures
Future is the type of derivative that indicates a contract between two parties to buy and sell a security or an asset at a fixed price on a fixed date. One cannot change the price of the derivative; they see that the price of the share has increased and a lower amount has been kept fixed on the contract. It can be said that it depends a lot on probability as well.
- Options
Options also perform the same way as futures do except that the holder of a derivative is not obligated to exercise the contract. There is an obligation to trade in future derivatives, but options do not impose such an obligation. Hence, options are considered flexible when compared to futures.
- Swaps
Swap is used to change the form of derivatives. It implies that swaps can change a particular kind of cash flow into another. A commodity swap allows individuals to trade based on the price level of an underlying commodity. There exist several types of swaps based on the class of asset such as credit, default swaps, currency swaps etc.
Commodities
A commodity is a type of financial product that has a tangible existence and highlights some ownership or share of ownership by an individual or a group of individuals. Generally, trading in commodities involves things like precious metals or natural resources. In a broader sense, commodities also include soft commodities, such as livestock, agricultural products, dairy products, etc.
For instance, if an individual has reasons to believe that platinum prices will rise in future, then he may invest in platinum now and can earn profits when its prices potentially rise. The changing price of the commodities in various time periods is the key to earning profits in commodity trading. That is why commodities are generally recorded in portfolios as a hedge against inflationary pressure.
Generally, commodity trading becomes more popular if the stock market and other security trading encounter a sudden fall. Trading directly in commodities is a complex procedure and difficult when compared to trading in securities.
However, individuals can indirectly invest their money in commodities by investing in various securities held by several companies that are responsible for manufacturing those commodities.
Currencies
Currencies are not fundamentally considered as a separate asset class or a financial product but can be included in the list because they can be traded in the market as well. Currencies are generally traded on cryptocurrencies, which are foreign exchanges that allow people to convert one type of currency to another. Currency trading is an absolute necessity as different countries and companies need to trade with each other.
However, there is no centrally controlled marketplace for currency trading as it exists for securities and stock trading. It indicates that currency trading generally occurs between individual investors. Individuals make money on forex markets in the form of currency trading as shifts in price take place.
With the advent of the Internet, current trading has become easier and more prevalent throughout the world. With the inclusion of online, foreign exchanges, currency trading has become widely accessible.
The above-mentioned financial products list is a partial list. These are the major types of financial products. However, there exist other miscellaneous financial products as well that may or may not align with companies and market conditions at all times.
Conclusion
It is significantly important to understand the basic concept of financial products to start your journey in the financial markets. One can enrol for the investment banking courses offered by Imarticus Learning to understand how financial products are dealt with.
Understanding financial products helps individuals and companies to invest in a smart manner which helps them maintain the operational stability and monetary flow within the company. A career in investment banking comes with a lot of lucrative opportunities which you would not like to miss out on.
